The general public, together with economists unfamiliar with UK-EU cost-benefit analysis, probably found this week’s Brexit report from the Treasury persuasive, while cautiously acknowledging that they were being “scared”.
Treasury economists, who are familiar with the economic arguments, clearly found it persuasive too – they produced it after all – although one must add the obvious caveat that the government was never going to publish a report which contradicted the position it had already taken. Such reports are all too often a fudge; between the professional pride of the monkey and the political necessity of the organ grinder.
So was this a serious, professional piece of work, or a blatantly partisan document fit only for loo roll? Here’s my attempt to be as fair as possible to the views of both camps, Leave and Remain.
Let’s deal with the Treasury argument first. The chancellor argues that the Single Market increases trade and “openness” by removing tariffs and quotas, abolishing customs checks, and creating a level playing field through harmonisation and the dismantling of non-tariff barriers.
He argues that reduced non-tariff barriers are a significant gain – for example the effect of passporting rights in financial services. Greater openness is said to increase trade and foreign direct investment, thereby boosting productivity and long-term GDP growth. The Treasury also highlights the potential risk to high value supply chains across the EU (in aerospace, for instance) from being outside the customs union.
To add further weight, the trade creation effects of EU membership are said to be large, while the trade diversion effects are small. By implication, there is limited scope to re-orientate trade – after Brexit – to the rest of the world outside Europe.
Moreover, the Treasury argues that future liberalisation of the services and energy markets across the EU would bring further substantial gains to the UK economy. The automotive (10 per cent tariff threat) and financial services (potential Single Market rules forcing the re-location of chunks of the City to the continent) sectors are picked out as being particularly vulnerable to Brexit.
And finally, just to stick the boot in, the Treasury argues that the three available alternatives to EU membership (the EEA, World Trade Organization rules, or bilateral agreements) are all worse than the status quo and will reduce openness. It argues that we couldn’t get Single Market access without a price (a fiscal contribution and/or free movement of people), or we would be getting a better deal than existing EU members.
Anticipating the charge from leavers that the UK could liberalise the domestic economy with deregulation post Brexit, the Treasury points out that the UK is already highly competitive when measured by OECD measures of product and labour market regulation, and that the potential supply side gains are illusory. I think that’s a fair summary and these are all true or plausible arguments.
But leavers, of course, have a different perspective. The Treasury uses a gravity model to measure the economic consequences of the EU Single Market for trade. But there is also another way to model the effect of EU membership, by using computable general equilibrium models to estimate the impact on the UK economy from the EU common external tariff (CET).
The CET raises prices above world levels and independent research (unrelated to the EU debate) suggests that the CET and non-tariff barriers impose a significant cost on the economy: directly, in the case of higher food or car prices for consumers, for example; indirectly, from the reduced competitive stimulus gained by trading at world prices. Economic theory would suggest that productivity will be maximised when an economy fully exploits its comparative advantage – at world prices.
Leavers also argue that the supply side gains from Brexit could be considerable. The UK may perform “relatively” well already in areas like labour market regulation, but the scope for “absolute” improvement is still huge.
Finally, leavers argue that the EU economy is heading in the wrong direction, mired in stagnation, and that status quo or Single Market liberalisation stories don’t cut the mustard. A more realistic appraisal of the EU’s economic problems would yield a much more pessimistic view of its future growth rate, and ours, without Brexit. Possible sectoral problems caused by Brexit (in the car industry or the City) are recognised by leavers, but are said to be manageable with much lower Corporation Tax and other incentives for businesses to stay, freed from EU law.
Leavers also remember that, back in 2003, the Treasury stated that UK trade could increase by 50 per cent over the next 30 years if we joined the euro. Even if we had been converged, and had joined, subsequent events make the projection seem ridiculous.
Amazingly, this is all quite easy to summarise. The Remain estimate of the cost of Brexit is 6 per cent of GDP by 2030 – less than 0.5 per cent per annum. Against this are the benefits proposed by leavers, namely the increase in productivity and economic growth from: first, trading at world prices; second, supply-side improvements (a smaller tax and spend burden and deregulation); and third, a truly global focus, recognising the shift from West to East in the economic centre of gravity. The academic literature strongly suggests these three effects would add up to much more than 6 per cent of GDP by 2030.
By revealing his hand, the chancellor may have made a fatal error.